What does a higher US Dollar Index indicate? Essential global capital flow analysis techniques for investors

What exactly is the US Dollar Index?

In financial markets, we often hear terms like “S&P 500” and “Dow Jones Industrial Average,” which track the performance of a basket of stocks. But did you know? There is another equally important index that tracks not stocks, but the value changes of the world’s strongest currencies—that is the US Dollar Index (USDX or DXY).

Simple definition: The US Dollar Index measures the strength of the US dollar relative to six major international currencies. These six currencies are the euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc.

Think of the US Dollar Index as a “barometer” for the global financial market. Since the dollar is the world’s primary transaction and settlement currency, whether it’s crude oil, gold, commodities, or cross-border investments, most are priced in USD. Therefore, changes in the USDX actually tell us about the global capital flows and market sentiment.

What currencies make up the US Dollar Index? How are the weights distributed?

The USDX covers six currencies, but the countries behind these currencies are far more than six. The Eurozone alone has 19 countries using the euro, plus other countries using the other five currencies, covering over 24 developed economies.

The weights of these currencies are not evenly distributed but are calculated based on the size of their economies, trading volumes, and currency influence using a “geometric weighted average” method:

The euro accounts for over half of the index, because the European economy is huge and is the second-largest international currency after the dollar. This also means that once the euro fluctuates, it can have a significant impact on the entire USDX. The yen ranks second, mainly because Japan is the third-largest economy globally, and the yen is often used as a safe-haven asset due to low interest rates and high liquidity.

What does a higher US Dollar Index mean? The direct impact of dollar strength or weakness on investments

When the US Dollar Index rises: a cycle of dollar appreciation begins

When the USDX is higher, it indicates that the dollar is stronger relative to other major currencies. During this period, the following phenomena tend to occur:

Advantages for the US:

• Import prices decrease, boosting US consumers’ purchasing power
• Global capital flows into USD assets, pushing up US stocks and bonds
• US economic growth momentum is strong, with optimistic corporate earnings prospects

Challenges for other countries:

• Export-oriented economies (like Taiwan) face reduced competitiveness, as their goods become relatively more expensive internationally
• Emerging markets face increased repayment pressure on USD-denominated debt
• Capital flows withdraw from Asia and emerging markets, moving toward the US

When the US Dollar Index falls: opportunities brought by dollar depreciation

Conversely, when the USDX declines, it indicates the dollar is losing appeal on the international stage. At this time:

• Hot money begins seeking other investment opportunities, with Asian stock markets and emerging markets becoming favored
• Export-driven economies benefit, as their goods become more competitive
• Investors holding USD assets face “exchange loss” risks—dollar depreciation means converting back to their home currency will yield less value

How is the US Dollar Index calculated?

The USDX uses a weighted geometric mean calculation, with the core formula as:

Dollar Index = 50.14348112 × (USD/EUR)^(-0.576) × (USD/JPY)^(-0.136) × (USD/GBP)^(-0.119) × (USD/CAD)^(-0.091) × (USD/SEK)^(-0.042) × (USD/CHF)^(-0.036)

Interpreting this formula:

The “50.14348112” is a fixed constant used to normalize the index to 100 at the 1985 base period. Each term inside the parentheses represents the USD exchange rate against another currency, with the exponent indicating the currency’s weight.

The key point is: The USDX is not a specific exchange rate or price but a relative index. It reflects the overall strength or weakness of the dollar compared to the six currencies since the base period.

• Index = 100: equal to the base level, no appreciation or depreciation
• Index < 100 (e.g., 76): down 24% from the base, dollar is weakening
• Index > 100 (e.g., 176): up 76% from the base, dollar is strengthening

In simple terms, a higher USDX indicates a stronger dollar; a lower USDX indicates a weaker dollar.

The interaction between the US Dollar Index and global assets

Relationship with US stocks

The relationship between US stocks and the dollar is not strictly positive or negative but depends on the market environment:

• When the dollar appreciates along with economic growth, capital flows into the US, and both stocks and the dollar rise
• But if the dollar appreciates excessively, it can hurt US export competitiveness, dragging down the overall stock market

For example, in March 2020, at the start of the pandemic, global stocks plummeted, but due to safe-haven demand, the USDX soared to 103. Later, as US COVID-19 cases surged and the Fed launched massive stimulus, the dollar quickly weakened to 93.78. This shows that the relationship between stocks and the dollar needs to be judged in the context of current economic and policy conditions.

The “see-saw” relationship between gold and the dollar

Gold and the dollar exhibit a classic negative correlation:

• Dollar appreciation → Gold priced in USD rises in cost → Gold prices fall
• Dollar depreciation → Gold becomes cheaper in USD → Gold prices rise

This is because gold is priced in USD; when the dollar is strong, holding gold becomes more expensive. Of course, gold prices are also influenced by inflation expectations, geopolitical events, and oil prices, but the dollar’s strength or weakness remains a key factor.

Impact on Taiwan stocks and the New Taiwan Dollar

When the dollar appreciates, it usually puts pressure on Taiwan markets:

• Capital flows back to the US, putting selling pressure on Taiwan stocks
• The New Taiwan Dollar faces depreciation pressure
• Import costs rise, and export competitiveness declines

Conversely, when the dollar depreciates, it often benefits Taiwan:

• Capital inflows into Asia boost Taiwan stocks
• The New Taiwan Dollar may appreciate, making imports cheaper but potentially limiting export growth
• US stocks and bonds denominated in USD, when converted to TWD, may lose value

However, these relationships are not absolute. Sometimes, optimistic global economic outlooks can lead to simultaneous rises in US stocks, Taiwan stocks, and the dollar; during black swan events, all assets may decline together.

What drives the rise and fall of the US Dollar Index?

Federal Reserve’s interest rate policies

This is the most direct factor affecting the USDX.

Rising interest rates → higher US interest income → global capital inflows into USD assets → dollar appreciation → index rises

Lower interest rates → capital outflows from USD → dollar depreciation → index falls

Every Fed meeting and policy announcement is closely watched because this policy has an immediate impact on the USDX.

US economic fundamentals

Indicators like employment data, CPI inflation, GDP growth directly reflect the strength of the US economy:

• Strong economic data → increased market confidence → dollar strengthens
• Weak economic data → investor concern → dollar weakens

Geopolitical events and risk aversion

Wars, political turmoil, regional conflicts and other global events trigger safe-haven demand. During these times, the dollar, as the world’s reserve currency, becomes the preferred safe asset, leading to the phenomenon of “the more chaotic, the stronger the dollar.”

Performance of other major currencies

Since the USDX is a relative index, when major currencies like the euro and yen weaken due to their own economic issues or easing policies, even if the dollar itself doesn’t appreciate, the USDX can still rise. In other words, the depreciation of other countries’ currencies can also lift the USDX.

US Dollar Index vs. Trade-Weighted US Dollar Index: Which is more important?

When analyzing dollar strength, investors often confuse these two indicators. What’s the difference?

US Dollar Index (DXY):

• Most common, most frequently reported by media
• Based on the exchange rates of the dollar against six major currencies
• Compiled by ICE (Intercontinental Exchange)
• Over half the weight is on the euro, reflecting a Euro-American perspective

Trade-Weighted US Dollar Index:

• The official indicator mainly referenced by the Fed
• Weighted based on actual US trade partner countries
• Includes over 20 currencies, covering Asian emerging markets (RMB, TWD, KRW, THB, etc.)
• More accurately reflects actual US trade exchange rates and global market conditions

In summary: The USDX is a quick tool to gauge market sentiment; the trade-weighted index is a core reference for Fed decisions and in-depth macro analysis. Most investors can rely on the USDX, but for forex trading or understanding Fed policy logic, the trade-weighted index offers deeper insights.

What investors should know: Practical applications of a high US Dollar Index

Understanding what a high USDX signifies can help you:

1. Assess capital flows: Rising index suggests capital may be flowing back to the US from Asia
2. Adjust asset allocation: During dollar strength, reduce exposure to emerging markets and increase USD assets
3. Capture exchange rate opportunities: Forex traders can predict currency trends based on index movements
4. Evaluate export/import companies: Exporters face challenges when the dollar appreciates; opportunities arise when it depreciates

Whether you are a long-term investor or a trader, mastering the movement of the USDX is essential for understanding global financial market dynamics. This indicator acts like a “wind vane” for global capital flows; observing its fluctuations can help you better identify risks and opportunities.